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Stretching your pension investments

If you’re 65 and retired your priority is to make your money last for at least the rest of your life. If possible, the capital should grow at a rate higher than inflation, without taking undue risk.

Modern medicine and a focus on healthy living have ensured that for many, the decades after 65 can be actively spent in building relationships with grandchildren, travelling and being engaged in stimulating work or volunteering – the proviso being that you have to have the money to pay for these activities.  

Retirement assets could be classified in either one of three categories, as in the graphic shown below.

Type 1: Those that have come about due to an inheritance, selling a business, or saving without the benefit of using tax rebates to encourage saving for retirement. No rules stipulate how, when or where these assets should be invested, or how they should be passed on to dependents.

Type 2: Assets that have been accumulated by virtue of being a member of a pension fund or a retirement annuity (RA) fund. Up to one third of the proceeds may be taken as a cash lump sum (net of tax) and at least two thirds must be used to purchase an annuity of some sort. Compulsory annuitisation applies to fund balances above R247 500.

Type 3: Assets invested in a provident fund. The full amount may be taken as a lump sum net of any applicable tax. New rules that require provident fund members to use two-thirds of their fund benefit to purchase an annuity at retirement were postponed to March 1, 2018. At the time of writing (October 2017) it is unclear whether the new law will be enforced in March 2018 or not.

Categories of post-retirement assets

*Note that retirees could own assets that fall in one or more of these categories.

Generally speaking, at Rosebank Wealth Group we have found that there is no ‘one size fits all’ approach to investing; but in retirement, this is more true than ever. During the course of a long life there can be many expensive curve balls – including divorce, ill health, failed businesses, dependent children, insolvencies and retrenchment.

Advice has to be tailored according to whether or not assets are housed in annuity products, the rules of product types designed to provide an income to retirees, the total value of assets owned by clients, what percentage of these are offshore, current financial needs and the objectives of retirees themselves.

Below are a few points that could be considered when thinking about retirement planning and should not be understood as investment advice.

History tells us that the best-performing asset class over time has been equities, followed by property, bonds and cash. ‘Investment nirvana’ for a retiree is to have a large capital base invested in such a way that the performance of the portfolio is higher than the rate of inflation and spending requirements. In this way, the capital base is never eroded.

The main difference between those who have a generous provision for retirement and those who do not, is that those with more money have a wider set of investment choices. If you have more money, it is likely that you will be able to benefit from a longer investment time frame. This translates into greater opportunities for constructing a portfolio which might be both more risky and have better returns over a full investment cycle.

Very few investors or retirees achieve the situation described above.

This is sobering and scary for investors who have the bulk of their income-generating years behind them. We strongly recommend that couples nearing retirement should consult an advisor to discuss short-, medium- and long-term investment needs, and develop a plan accordingly.

When and if you have this discussion with your advisor, remember to insist that investment risk should be defined as the risk of the asset not outperforming inflation, not the volatility of investments, the maximum drawdown of an investment or the ‘value at risk’ of an investment.

Financial advice columns are full of educational articles on how to invest for your retirement. Many of them attempt to distil investment advice to ‘rules of thumb’ that are not applicable to current markets. In sideways-trending markets and when it is imperative not to outlive your investments, good financial advice is priceless.

We have focussed on two important considerations; the choice of investment vehicles to actually house your assets and some of the tax reduction options available to retirees.

Housing your assets in the right vehicle

The choice of investment vehicle to house underlying holdings can make a material difference to the after-tax income earned by pensioners.

  • Living annuities versus guaranteed annuities: If you are obliged to choose an annuity from an insurer, be aware of the very important differences between a living, a guaranteed and a guaranteed-with-profits annuity.
    Five years ago, guaranteed annuities were probably at the low point of their popularity, as markets and investors were confident, markets booming and guaranteed annuity products derided because they were expensive. Further, at your death, any residual assets were retained by the insurers. As of 2017, investment confidence and returns have decreased and the prospect of a ‘retirement pay cheque for life’ is more appealing. Also, the downturn has prompted a wave of financial innovation. Avoid the mistake of reading five-year-old investment articles when deciding which type of annuity to buy.

    Consider splitting your retirement fund into two funds; one housed within a living annuity and the other housed in a guaranteed annuity. A good independent financial advisor will be able to inform you of new products and how to evaluate them.

  • Endowment policies: Equity remains the asset class of choice for long-term growth, but the capital gains tax (CGT) levied on the sale of shares can seriously dent after-tax returns. A further benefit is that there are no asset class restrictions on endowments; investors are free to invest across asset types, and geographies.
    Type 1 pensioners should ask their financial advisors about the benefits of housing a direct equity portfolio within an endowment policy. Tax on income is levied at a flat rate of 30% within the endowment; this presents an opportunity for pensioners who pay more than this rate.
  • Section 12J Venture Capital Investments: In the 2009 Budget Speech, the Minister of Finance announced the introduction of Section 12J of the Income Tax Act, which was designed to encourage venture capitalists and high net-worth investors to create economic growth and jobs. Investors were provided with an option of investing in projects that created employment, in return for tax rebates. Initially the terms and conditions of qualifying investments were too onerous, and there was not much uptake.
    However, more recently, the investment rules have been modified and there has been interest. This vehicle is not for everybody, as your capital is tied up for five years and should only really be looked at in conjunction with the tax rebates offered. But for those with money that has a longer time frame, some excellent projects have come online, which are definitely worth exploring.
  • Investing in ‘alternative assets’ including hedging strategies: Traditional hedge funds were initially designed to hedge against negative performance – just the thing you want when you are retired and do not want to lose your capital. South Africa has been one of the first countries to comprehensively regulate hedge funds and we at Rosebank Wealth Group envisage them becoming a larger part of the retail savings industry.

Tax considerations

In many developed countries, retirees are ‘royal game’; regulators assume that retirees have worked hard for the money and should be afforded some comfort in their twilight years. However, in South Africa, only 6% of the population are over the age of 65, and this group includes some of the wealthiest South Africans. With reduced tax inflows, Sars is looking afresh at ways to tax the wealthy, whatever age they are.

CGT could increase, estate duties may be increased, rules about which assets qualify for estate duty exemption and which ones do not may change. South Africans therefore owe it to themselves to make use of all the tax breaks they can to sweat their retirement assets.

  • Type 2 and Type 3 pensioners (those whose assets have been housed in an annuity) are usually aware that retirement assets (which would have come from a pension, provident or RA fund), are not liable for CGT, dividends withholding tax or income tax on the investment growth earned. However, your annuity income will be taxed according to the current income tax tables.
  • All over-65s and over-75s are eligible for rebates payable on interest earned. As of 2017, the secondary rebate for over 65s is R7 110 and the tertiary rebate for over 75s is an additional R2 367.
  • All retirees could make full use of the tax-free investments introduced by the Minister of Finance in March 2015 as an incentive to encourage household savings. You can invest a maximum of R33 000 per year, up to a maximum of R500 000 in your life time.
  • Sars has made it more difficult to abuse trust structures merely for the purpose of paying less tax. However, there are many cases where the use of a trust structure is a legitimate conduit of family wealth from one generation to the next. Ask your financial advisor if housing your assets in a trust could benefit you and your beneficiaries.
  • Find out about which assets are exempt from estate duty, executor’s fees and/ or CGT on death.

Understanding the source of performance in different investing environments and in different asset-classes, and the tax rules applicable to different types of investments, can make a big difference to your retirement income.

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